Episode Details

With mortgage rates at their highest level in 20 years, housing affordability may deteriorate to levels not seen in decades.

----- Transcript -----

Jim Egan: Welcome to Thoughts on the Market. I'm Jim Egan, Co-Head of Securitized Products Research here at Morgan Stanley. 

Jay Bacow: And I'm Jay Bacow, the other Co-Head of Securitized Products Research. 

Jim Egan: And on this episode of the podcast, we'll be discussing U.S. home prices. It's Tuesday, October 31st at 11 a.m. in New York. Happy Halloween. 

Jay Bacow: Jim. Mortgage rates are close to 8%. They haven't been this high since the year 2000. Now, you've pointed out in this podcast before, home prices have been incredibly resilient. So what is this combination of mortgage rates being at the highs over the last 20 years versus resilient home prices mean for housing affordability? 

Jim Egan: Well, not good. Now, one of the statements that you and I have made on prior episodes of this podcast is that affordability remains incredibly challenged. But at least throughout the first half of 2023, it really wasn't getting any worse. If mortgage rates stay at these levels, we can no longer make the second half of that statement. In fact, affordability deterioration would return to the most severe that we've seen in decades, 2022 experience notwithstanding. 

Jay Bacow: Okay. But what does that mean for the housing market? You know, at first blush, it doesn't sound great, but we've done a lot of these podcasts, and the story that you're talking about sounds kind of similar to what we saw last year in 2022. Home sales and housing starts could fall, but home prices would remain protected as homeowners are effectively locked in to their current low mortgage rate and there's not a lot of for sellers. 

Jim Egan: Those dynamics certainly continue to play a role in our thinking. But in our view, with mortgage rates at these levels, that requires us to think about both the short term impacts but also the longer term impacts if we were to stay here. 

Jay Bacow: All right, Jim, you said shorter term first. So what do we think happens in the near future? 

Jim Egan: Basically, what you just described, look, the immediate reaction to the recent climb in mortgage rates has been on the supply side. Existing listings have begun falling again, as of August we can now say that we have the fewest listings on record, controlling for time of year, the housing market is very seasonal and homebuilder confidence has also retreated. Now it increased in every single month of 2023 from January through July. In the past three months, it's down over 30% from that peak, and the NAHB attributes a lot of this u-turn to higher mortgage rates. At least when it comes to home prices, we think that the impact from these renewed decreases in the supply of homes is going to have a greater impact on prices than any decrease in demand. In fact, that did cause us to move our home price forecast a couple of months ago. We were flat at the end of this year and again, we're saying short term, this is October, the end of this year is pretty close. Our bull case was plus five. We're not moving all the way to that plus five, but we're moving towards that plus five from our 0% base case. 

Jay Bacow: All right. So over the next few months, you're a little bit more constructive on home prices, but people own homes for many years. So longer term, what do you expect the outlook to be? 

Jim Egan: Well, the answer there is, you know, more predicated on how long mortgage rates stay at these levels. We do think that a higher for a longer environment requires a di